How To Better Manage Your 401K For Retirement Success

Early retirement is fantastic. There’s only one problem. Most early retirees no longer contribute to their 401Ks unless they start a business. Not only that, early retirees lose employer 401K match and profit sharing. I just took a look at my final year’s employer 401K profit sharing plus match and it came out to $27,000. There’s much more to your job than just your salary!

My 401K makes up a minority portion of my stock exposure as I’ve been aggressively investing through structured notes and after-tax accounts. Furthermore, I’ve been receiving more deferred company stock than desired. Although $400,000 is not a lot to retire on, it’s the best I could do after maxing out for 13 years after college. It should serve well for illustrative purposes to see how a portfolio can grow under different assumptions.

With the way the government loves to spend our money, I wouldn’t be surprised if the retirement age for distribution without penalty increases beyond 59.5 or the government imposes a “distribution tax” to take more of our money. That said, we can hope for the best by reducing our mutual fund expenses and creating different scenarios to better prepare for our future.

The best way to increasing our odds for retirement success is to run various investment scenarios. I will run three investment scenarios (Conservative, Realistic, Blue Sky) using the free 401K investment analyzer by Personal Capital. Regardless of whether you are retired or not, I encourage everybody to perform at least these three scenarios and write down some notes. Early retirees need to be extra diligent given we are more dependent on our investments to survive. If you have years to go before retirement, I suggest you pretend you are retired now so you can develop a fire to be all over your money!

CONSERVATIVE 401K PORTFOLIO SCENARIO

General Instructions: It looks like plenty of you have signed up already so this will be a good tutorial. For those who haven’t, once you have signed up for Personal Capital and linked your 401K, go to the “Investing” tab on the top right and then choose “401k Fee Analyzer.” This is the page where we plan to do all the analysis to get an idea of how different assumptions make big differences.

Base Assumption: The 401K alone is not enough to provide for a comfortable retirement. A 401K needs to be coupled with Social Security and other after tax investments to give ourselves a chance for financial security. We will use my 401K balance at the end of 2016 as an example. After reading this post you should input your own. I assume no contributions and no employer match or profit sharing forever. Portfolio growth assumption is 4% per year with 0% additional fees. 4% annual growth is conservative given the average return for the S&P500 since the 1950’s until now is roughly 7%. The 2009-2010 economic downturn helped bring the average down.

The Good: Despite not contributing anything to the 401K, even a conservative assumption of 4% allows the 401K to grow by $754,920 to $1,160,000 by the time I’m 65. $1,160,000 is OK if I were to live abroad or in cheaper US locations, but it won’t go far in San Francisco or New York City.

The Bad: In 30 years, things will be much more expensive thanks to inflation. Honda Civics that now cost $20,000 will probably cost closer to $40,000. I expect all prices to at least double in 30 years if inflation runs at 2.3% a year using the rule of 72. Hence, the buying power of $1,160,000 is more like $580,000 in today’s dollars after fees. Let’s subtract another 20% income tax on $580,000 (spreading the distribution out), and I’m left with only $464,000. The figure is kind of depressing after starting off with $1,160,000.

Conclusion: Once you’ve built a decent sized nut, investment performance is the #1 criteria for portfolio growth and not contributions. The key is to build that nut. With ~$464,000 in buying power after taxes, fees and inflation, I could probably only live comfortably for 5-8 years in retirement before the money runs out. As a result, I need to rely on the government’s good graces, which is always a crap shoot. By now, I hope alarm bells are ringing in your head as to why it’s so important to max out your 401K and IRA.

REALISTIC 401K PORTFOLIO SCENARIO

Portfolio Assumptions: I assume $10,000 total annual 401K contributions (includes employer match) and a 1% higher 5% per annum investment return for 30 years. In my case, the contributions come from a self-employed 401k plan. If you are working, contributions will just come from your paycheck and employer.

The Good: By just contributing $10,000 a year and performing 1% better, the total gross 401K figure after 30 years grows by $1,551,642 to $2,429,266, or more than double the conservative case scenario. Meanwhile, the percentage lost to fees goes from 17% down to 14% or two years of retirement lost compared to four years lost. $2.4 million should be enough for most people to live comfortably in retirement.

The Bad: I’m still paying $262,693 in fees based on my existing portfolio largely due to a Fidelity Blue Chip Growth Fund that has a 0.74% expense ratio vs. 0.35% or lower for similar Vanguard Funds. We should all run the mutual fund fee analyzer on our 401Ks and see where we can optimize.

Conclusion: A little effort goes a long way. When you combine multiple improvements to your portfolio (increased contribution, increased employer match, and 1% increase in annual growth), you end up with explosive long term results. Let’s cut the $2,429,266 in half due to inflation to account for today’s dollars. We get $1,214,633. Take 20% tax and we’re left with $971,706 in buying power. I can live comfortably for the next 11-20 years just off my 401K. Unfortunately, I plan to live longer than age 72-80, which means the 401k is still not enough or I have to cut down on my lifestyle.

BLUE SKY 401K PORTFOLIO SCENARIO

Portfolio Assumptions: Let’s contribute $17,000 a year, receive a $17,000 match/profit sharing from our employer, and earn a 7% annual return. Please note for 2013, the maximum contribution is $17,500. We aren’t Warren Buffet or Bernie Madoff, so 7% will have to do to account for large double digit returns and losses throughout the years. Remember, it’s still better to be conservative in a Blue Sky scenario because you don’t want to come up short in retirement.

The Good: We don’t have to financially worry in retirement anymore! By maxing out our 401K ($17,500 for 2013), receiving a 100% employer match, and returning a reasonable 7% a year thanks to good research and good luck, our 401K has now grown by $4,821,749 to $6,844,000. The Blue Sky scenario leads to an amount 2.5X greater than the base case scenario. Furthermore, we’ll probably earn at least $30,000 a year in Social Security. Note that you can contribute up to $51,000 in your self employed 401K up to 25% of profits.

The Bad: $647,216 in fees is an incredible amount that equates to 10% of my entire 401K balance. Think what you can do with $647,216? I’m imagining a $147,000 Range Rover 2013 Super Charger with $500,000 left over to go on 10 world cruises! Even a half percent in fees really drags down returns over time. Furthermore, we are assuming we’ll have the desire to work until age 65. I thought I was going to work until 40, but got tired and wanted to pursue my online endeavors. Things are always changing.

Conclusion: Maxing out our 401K, working for a company until 65, and doing due diligence on our investments pays off big time. A lot of folks hop around firms, resulting in a temporary stoppage of compounding and contributions since it takes a while for shares to vest. If we can stick it out with a company long enough, while diligently saving by adjusting our lifestyles accordingly, there is no doubt we will become multi-millionaires by the time we are 65.

Take half of $6,844,000 for inflation and 30% off for taxes and you still get around $2,400,000 in today’s dollars for retirement. With $2.4 million and no mortgage at 65, life is easy. We can book first class tickets to Bali and stay in a waterfront bungalow for a month. We can eat and drink until our heart’s content. We can pay for our children’s education and help the poor. The best thing is that during all our years, the markets did most of the work and we probably didn’t even notice the pre-tax savings pinch.

2) Run multiple scenarios based on different savings, matching, and investment returns. I only introduced three, but you can and should put in your own assumptions in the 401K Investment Analyzer section. We all have different 401K amounts, risk tolerances, and investing prowess.

3) Estimate the net present value of your retirement savings and account for taxes. Inflation is a real killer, which is why you should consider investing in real assets that inflate over time e.g. real estate.

4) Draw some conclusions after each scenario analysis. Conservative portfolio scenarios generally require extra after tax savings and/or alternative income streams to fund retirement. You don’t want to end up short in retirement so it’s best to keep your forecasts low.

5) Set realistic return goals and consider rebalancing when such goals are achieved. It’s important to have discipline during extreme market swings.

I’ll be the first to admit I love doing scenario analysis in practically everything I do e.g. comparing jobs, choosing schools, buying a car, picking a vacation, battling opponents in sports etc. Ever since I was a kid, I’ve been a dreamer. Even today, I enjoy dreaming about what I would do if I won the World Series Of Poker or the Powerball lottery. When a free tool like Personal Capital makes it so easy to test different assumptions, why not do a little dreaming?

To replicate the charts in this post with your own figures simply sign up for Personal Capital, link your portfolio(s) on the left hand side of the dashboard, and then click Investing tab on the top right to see the results. The process only takes a a minute to sign and is completely free. I recommend running your 401k and investment portfolios through the Retirement Fee Analyzer tool as well. The software found $1,700 in 401k fees I had no idea I was paying. Finally, you can easily track your net worth in one place automatically.

About the Author: Sam began investing his own money ever since he first opened a Charles Schwab brokerage account online in 1995. Sam loved investing so much that he decided to make a career out of investing by spending the next 13 years after college on Wall Street. During this time, Sam received his MBA from UC Berkeley with a focus on finance and real estate. He also became Series 7 and Series 63 registered. In 2012, Sam was able to retire at the age of 34 largely due to his investments that now generate over six figures a year in passive income. Sam now spends his time playing tennis, spending time with family, and writing online to help others achieve financial freedom.

Updated for 2018 and beyond. 401k maximum contribution from the employee’s side increases to $18,500 for 2018. Then there is the employee profit sharing contribution that can bring your total 401k contribution to $54,500. It’s now more important than ever to be diligent about your 401k and investments. We’ve gone through a huge recovery and there is usually a period of volatility and consolidation.

Author Bio: Sam started Financial Samurai in 2009 to help people achieve financial freedom sooner, rather than later. He spent 13 years working in investment banking, earned his MBA from UC Berkeley, and retired at age 34 in San Francisco.

Sam’s favorite free financial tool he’s been using since 2012 to manage his net worth is Personal Capital. Every quarter, Sam runs his investments through their free Retirement Planner and Investment Checkup tool to make sure he stays financially free, forever. It’s free and easy to use.

For investing opportunities in 2019, Sam is most interested in investing in the heartland of America through real estate crowdfunding. Property valuations are much cheaper and net rental yields are much higher. There is a demographic trend towards moving away from higher cost areas of the country to lower cost areas thanks to technology.

@AvgJoe, I do, I do! I have been tracking my own progress towards retirement since 1994, along with the changing NW, Goals, and Earned Value. An example to bolster your point: in 1999, after 5 consecutive years of 20%+ stock market returns where everyone was a genius, 29 year-old Ryan Jacobs was managing a tech fund returning 90% annually and on the cover of every PF and business magazine, my NW was 1/3 of what is is today, yet the “Realistic” numbers showed me I could retire.{s_canned laughter}

This is a really cool post Sam. I love how you say small differences plus consistency matters. It really does! What a big change in the outcomes. That’s good to hear they increased the max contributions this year. $500 sure doesn’t sound like a lot but it’s better than nothing. I need to pay more attention to the fees in my 401k for sure. It’s pretty painful to see how much money goes into them over time.

I need to run some scenarios too. Are you contributing to a solo 401(k) now that you’re self employed?
Mrs. RB40 is still maxing out her 401k so I think we will be OK in 25 years. You never know though.

Seeing those 401k fees in big bold numbers is really an eye opener. I’m doing more contributing to my IRA now that my 401k doesn’t get a match for the sole purpose of keeping those fees as low as possible.

I don’t do analysis like this very often, but I do always tend to err on the conservative side when forecasting possible portfolio returns etc… I’d rather end up with too much saved than too little.

I was all set to join my wife in retirement in 2008. But beginning in October 2007, the S&P 500 (75% of the entire US stock market) declined 57% over the next 15 months. Imagine looking at your life’s work of saving and investing, and seeing 43 cents for ever $1 you had just 15 months prior. I know, right?!?!!

Not one of them predicted a scenario where wealth would be destroyed so dramatically, the S&P would nominally be 10% lower in 2013 than it was in 1999, and forward-looking GDP growth would be less than 2%.

I’m not cr@pping on Personal Capital, and will try it. But for those who have not yet inferred the point I have implied above, the future is unknowable. It is good to plan. But life is long, and will be a lot longer for those with plans that crater under real-time stress testing.

JC, I hear what you say completely, which is why I’m thinking my “Conservative” scenario of 4% growth and 0 contributions forever might be optimistic! Worst case I think is 0 growth in 25 years and I have what I have now.

Personal Capital is simply a tool to help one get from point A to point B easier. I could walk 1,000 miles, but I’d rather use a car. I still have to drive!

Don’t forget that if you run a small business or partnership, you can do far better than the $17.5k per year. Basically, for 2013, everyone with decent revenue/margin can sock away $50k (IRS limit) per year in a tax advantaged 401k (employee 401k + safe harbor + profit sharing contributions). Double this if you have a spouse that you also employ. Moving to $100k/year in tax advantaged savings is huge!

As someone who didn’t get clued into all of this until later in life (I’m 49 now), us older (and hopefully wiser) FI seekers get a bonus. Since I’ll be 50 later this year, I get the opportunity to invest an additional $5500 into my 401(k). I believe I’m allowed an additional $1000 investment in my IRA. I’m on track for an “early” retirement at 55 so I’m also putting money into taxable vehicles so I can live comfortably until I can/will access my retirement accounts.

Fortunately, I am a bit farther along than “just getting started”. I’ve got about $230K in 401(k) and IRA’s, $11K emergency fund, $10K misc cash (car fund, vacation, taxes/insurance, home improvements). The only debt I have is my house which will be paid off in 9ish years (at 2.625% I don’t feel the need to pay off sooner as the extra money is now going into investments). I just wish there had been information available like this 10 years ago. I’ve done a fair job savings but have really ramped up the past year and a half. I’ve gotten so many ideas from this community of bloggers. I can honestly say I detest my job and now I have the focus to exit the coporate foolishness sooner rather than later.

Hi Jeremy, profit sharing is different from company match in that it is a percentage of profits you receive based on your title at the company. The money, at least for me just gets injected into my 401K every year and allocated based on what I pre-determined.

I hope you do get to a scenario 2, or even a scenario 1 while building up your alternative income streams!

Excellent post and good to see how Personal Capital really works through the eyes of someone with your knowledge and experience. Whether with your 401(k) or an entire portfolio looking at several scenarios is the key to looking at where you stand in terms of your long-term financial planning goals. The one thing I would say (and this is from an avid index fund/ETF user) is that while low expenses are a very key factor, paying for solid, consistent active management is not a bad thing either. I still use a number of active mutual funds for both my individual client base and in the 401(k) plan sponsor for whom I provide investment consulting advice.

Roger, I appreciate you stopping by. No doubt there are index+/active fund managers who have shown historical prowess to consistently outperform the markets. I know and worked with many of them over the past decade. The key then is to really do your research on the active funds and the fund manager! I’ll put together another post on this. Cheers

Great post Sam! Need to break my habit of avoiding detailed scenario analysis. The results always point to a gloomy retirement due to a possibility of not having enough to live comfortably in the golden years. Thanks for the wake up call to be more responsible and will give this tool a spin!

Thanks Ben. Yes, I really think it is unwise to blindly assume a 8% constant rate of return. 4% is much more reasonable in this low interest rate environment. Better to lower our expectations and come up with too much than come up with oops too short.

I am almost 47 and am very conservative with 55% of my portfolio in index equities with the rest in tips and enough cash to last about 2 years. 65% of our overall portfolio (my wife included) is in tax-deferred vehicles. In addition to cash I also have 2 index funds in a joint account and Roth IRA’s that were fully funded for every year we were eligible. I have 2 children and have saved (in ESA’ and 529’s) 70K (13 year old) and 56K (10 year old for college). Not counting the college savings, we have accumulated about a million dollars. Our only debt is our mortgage which is steep. We owe 235K (8.5 years left with a 3.25% int rate on a 10 year). My issue is that I am completely burned out with the corporate life and would like to do something on my own. My income drop will be steep but my wife runs her own practice and we can make up some of that with me helping her. I find myself paralyzed by fear of the unknown. Has anyone else here been in this situation? I am worried about health and dental benefits and don’t want to put my family in a bad spot. Yet, I am afraid the stress of the corporate world will put me in a grave early. Can anyone offer any suggestions that might help me overcome my fears? Thanks in advance. This is one of the best blogs on the internet. Not just for finances but overall.

MD, Sounds like you’re doing well. Does the 2 years worth of cash equal enough to cover paying off the house? Having a paid off house will reduce your stress and provide more monthly income because you’re not paying the mortgage. More importantly: You will sleep very good at night. As for insurance, for the 6 of us it costs about 14-16K a year and will probably go up over time. However, it is tax-deductable if you setup a 1099 or to your MD business practice. You have options…nice of you to set aside so much for your kids.

Obamacare will help wrt health benefits. In populous blue states, the prices and coverages are quite competitively priced with its Costco style volume discounting via the healthcare exchanges if you review the Silver plans.

My son is 20, working an entry level job part time. He is investing the money in a Roth as he is not eligible for a 401k. Do you have any advice since I know you do not advocate the Roth, and my son does not have a 401k?

I too am big on scenario analysis. I have a spreadsheet that I created a few years back that uses Monte Carlo analysis (1,000 simulations) based on estimated risk and return as well as other inputs. At the beginning of each year I update the inputs, and create a base case. This year’s base case assumes I will retire at 62 five years from now, and that I will live to 95. It assumes my portfolio will return 6 percent with a standard deviation of 16 percent.

Then I created an additional 17 scenarios. Each scenario changes one of the base case assumptions. I change asset allocation, inflation rate, Social Security assumptions, annual expense assumptions, tax rates, and the year I retire. I also figured out a way to model “black swan events”.

What I have learned is: inflation is the biggest retirement portfolio killer out there. My base case for this year gives me a 92 percent probability that I won’t outlive my money. The base case assumes a 3 percent inflation rate. If I increase the inflation rate to 5 percent, my probability of not outliving my money falls to just 38 percent. Ouch.

Surprisingly, if I model a 50 percent loss to my portfolio three years out into the future, my probability of not outliving my money only drops from 92 percent to 84 percent. This convinces me more than ever to not panic during major Market corrections, and stay the course.

My portfolio would be considered very aggressive for my age, as it closely mirrors the Vanguard 2040 Target Fund allocation. I can afford to be this aggressive because I am lucky to have a pension, and I am planning to have at least two years of living expenses in cash before I retire. I am currently maxing out my 401K, and Roth IRA. Like a lot of folks, my only regrets are I wish I had started earlier, and contributed more throughout my working years.

I like that you mentioned that one of the best ways to increase your odds for retirement success is to invest your 401K. I’ve heard that those who invest their money are 25% more likely to have all the available money they desire in retirement. I’ll have to keep these incredible 401K management tips in mind, but it’s also comforting to know that there’s pros that can help out in the management of it all!

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